UK tax: feeling the squeeze

'I think it's going to get worse before it gets better,' admits John Woodward, chief executive of the UK Film Council of the current state of UK film finance.'

For the world's third-biggest producer of films, the idea that the situation will get worse will not surprise many people. But local and international producers, studios and investors will need convincing that the UK is back on a clear and sustainable track.

There is no doubting that the last fortnight has been traumatic. To recap the story: two weeks ago the UK Treasury effectively closed off so-called Gaap funding, which the government claimed was simply tax avoidance.

Initially caught up in the measure was the remnant of the territory's once mighty sale-and-leaseback scheme, which affected a significant number of film projects. That was rescinded, to the relief of producers and financiers, after a few days of feverish lobbying.

But now the UK is trying to work out just where it stands.

What's the damage'

The first step, naturally enough, is to assess the scale of the damage in immediate financial terms. Now the sale-and-leaseback argument has been settled, the issue is solely one of Gaap partnership funding (by which rich investors could offset some of their tax liability through a partnership, writing off a paper loss in their annual returns).

Estimates of total Gaap investments in film for the current tax year vary from a few hundred thousand dollars to more than $3bn.

For producers, the only figures that really count are the holes in their own film projects. And it seems for most there was a plan B that has been hurriedly implemented.

'We don't shoot until the summer and so we have had quite a lot of time on our side. I think we've got the finance back in place.

'The ones that are financially viable will find other funds. We got a lot of offers from other funds and quite a lot of offers from equity funds in America.'

The confidence question

A less tangible effect is on confidence in the UK. The tax clampdown that initially dragged in sale and leaseback came out of the blue and at least gave the initial impression of panic or incompetence.

'What this does to overseas investors, I don't know. I think it robs them of any kind of confidence,' says Mark Shivas, director of Headline Pictures.

'We haven't been affected but I think the industry generally will badly be affected by that hiccup. The government can turn around and do the same thing again. People are very nervous.'

Woodward believes the accusations - specifically of government ignorance - are unfair and indeed the swift U-turn on sale and leaseback rather proved the government's commitment to film. The clampdown, he suggests, was not aimed at the film business but at tax avoidance across a number of industries that was on a scale that required urgent action.

It is true that the knock to confidence in the UK can be overstated. The measures may not have been expected but they cannot have come entirely as a shock.

'There was a very strong sense across the industry that at some point, those (Gaap) funds were going to be stopped,' admits Eaton.

'Often, you can only speak from your own experience. This is quite a selfish business. But from where I sit, this (the closure of the Gaap schemes) is an inconvenience rather than a disaster. When we reach the end of the year and look back on it, it will probably be viewed as that.

'Everyone has been aware that there have been funds that have been able to make quite a lot of money out of tax schemes and haven't always been putting money back into the business.'

The timing was certainly not good for the business, even if you accept that the government had little choice but to shut down widespread tax avoidance schemes that were going to blow a hole in the tax system.

'The issue we had at Vertigo was why this decision wasn't made in April (at the beginning of the tax year) rather than in March,' says Vertigo co-founder James Richardson. 'Had this been a decision in April, it wouldn't have affected all the films this year and we could have been prepared for next year. It has been another blow in the short term for the industry.'

What follows GAAP'

The more important question is what comes beyond the short term. Wrapped up in the discussion are questions about whether the UK is at a turning point - where tax loopholes are no longer a significant contributor to film finance. That theory will be tested in the coming months.

Given the appetite for tax breaks, inevitably, accountants and lawyers will be poring over the details of the government's announcements on Gaap to see whether anything can be salvaged.

Woodward says the tax authorities are already aware of attempts to shift from Gaap finance through partnerships to a sole trader route that has not been specifically covered.

'Some of the cowboys out there are regrouping,' he says, provocatively. But he warns the government is in no mood to tolerate what he calls a 'global cat-and-mouse game in which the rich look for places to hide money'.

While one can see the political logic in getting tough on tax, it is likely to mean significant change for the film business - a fact alluded to in Woodward's 'getting worse before getting better' statement.

Tax specialist Martin Churchill puts the question with characteristic bluntness: 'No-one in their right mind would invest in the film industry (without a tasx break). The big question is whether there is investor appetite. Is there life after Gaap''

Churchill, editor of <i>Tax Efficient Review, says there may well be life, but not necessarily as the industry has known it. 'There will be something to take the place of Gaap. Whether it will be as big as Gaap is another matter.'

There are some hopes for major slate financing deals that will try to emulate the private equity boom that has been so big in the US - though it is an idea that has its doubters.

The surest successes are likely to surround the attractive new options of Enterprise Investment Schemes (EIS) in combination with the UK tax breaks, but the scale may be smaller.

Already, interesting projects are emerging that are cashflowing the new UK tax credit and working with the UK's EIS.

But many new business plans are looking at low-budget, carefully targeted product, rather than the big pictures that Gaap may have funded over time.

Adjusting to the new size

Woodward acknowledges that the scale of production may be reduced, albeit not on the level of 2004 when sale and leaseback was reformed.

'Fewer films will get made and production will contract, although the idea that there will be a wholesale collapse (as in 2004) is totally wrong,' he says.

That may not be a bad thing, he suggests. The over-abundance of production before 2004 was a largely unspoken, but nonetheless real, issue.

Woodward believes the money will shift towards the best and most viable projects: 'The cream may find it easier to rise to the top.'

The tax loopholes may have backed a great many films but, he contends, they have not been and cannot be a stable base for production.

'We are reaching the end of the line (for film funding by tax loophole). There will be several more turns of the dice over the next year or so until everyone gets the message. What's not going to be there is the ability to go out and source 30% of your film from a tax fund.'

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